Home buyers across the country will be spared the possibility of getting hit with a costly double whammy from their mortgage lenders, thanks to a little-publicized action taken here by banking regulators.
In an unusual move, the Federal Home Loan Bank Board last week reversed a mortgage market rule it had adopted barely two months earlier. The rule would have permitted lenders in any state to impose prepayment penalties--often $1,000 or more--on homeowners whose loans they were calling in, using their "due-on-sale" powers.
Virtually all mortgages written since the early 1970s (with the exception of FHA and VA loans) contain "due-on-sale" clauses. They permit a lender to demand immediate, full payment of the mortgage--or to raise the rate without limit--if borrowers sell or otherwise transfer their ownership interest in the home financed by the loan.
Banks, savings and loan associations and other mortgage lenders use due-on-sale clauses to protect themselves against loss during periods of rising interest rates. By threatening to call in the debt, they can effectively prevent homeowners from passing on low-yielding, fixed-rate mortgages to new buyers, thereby prolonging the life of money-losing old loans.
The legal power of federally chartered lenders to enforce such clauses--even in the face of state laws seeking to restrict them--was affirmed last year by the U.S. Supreme Court and in congressional legislation. Neither the high court nor Congress, however, addressed two related, sticky issues: Can a lender invoking its due-on-sale rights also require borrowers to fork over a big prepayment penalty as well? And can federally chartered lenders impose such prepayment penalties if allowed by federal regulators, despite state laws that bar them?
For example, let's say an S&L discovers that a borrower sold his house last year and allowed his 9 3/4 percent, $120,000 mortgage to be taken over (assumed) by the new buyer, without the knowledge of the S&L. The lender demands immediate, full payment of the loan balance, and the seller is forced to comply.
Let's say that at the time of the forced payoff of the mortgage, the S&L then hits the original borrowers with a surprise double whammy: The loan contract contained a standard prepayment penalty clause, says the S&L. You owe us an additional 1 percent of the remaining mortgage balance, roughly $1,100. We want it now. In cash.
Had the Federal Home Loan Bank Board not reversed itself July 7, that scenario could have become reality for tens of thousands of future home-buyers. Mortgage lenders of any type, in any state--including individual seller-financers--could have written Catch-22 provisions into their loan agreements from May 1983 onward.
Not only could they block loan assumptions with standard due-on-sale language, but now could freely hit borrowers with heavy penalties, after cancelling the loan. Federally chartered lenders--who dance to federal, not state, regulations--could even thumb their noses at consumers in the estimated 15 states where legislatures have banned or restricted prepayment penalties on home loans.
Bank board regulations adopted with little fanfare April 26 would have opened the door to all this for the first time. The rules amounted to an important change from the board's own explicit ban against the double whammy that dated back to 1976.
In the spirit of "deregulation," however, the board made the change. Virtually no one noticed. No one, that is, except some sharp-eyed congressional staffers working for Senate Banking Committee Chairman Jake Garn (R-Utah).
Garn and Sen. William Proxmire (D-Wis.) wrote to bank board Chairman Edwin Gray requesting that consumers at least be allowed more time to comment on the new rules, given the significance of the policy revision. In a second letter in late June, Garn complained to Gray that "I don't believe it is fair to consumers" to permit a lender to first sock a borrower with due-on-sale, and then turn around and slug him with a prepayment fine.
Simply calling in a mortgage and disrupting a home sale should be penalty enough, argued Banking Committee staffers. Demanding money when the borrower is down and vulnerable would amount to an unnecessarily severe penalty--a postpayment debt, in effect--that could not be justified.
After two weeks of stewing, the bank board last week agreed with Garn. It changed its April rules by 180 degrees: Now, no lender, in any state, can charge a prepayment penalty in connection with a due-on-sale loan call.
Those lenders who gleefully began changing their home mortgage forms after the April regulations were published (and bank board sources say several large, interstate mortgage institutions did so) will have to throw them out.
The double whammy, a gleam in some lenders' eyes, is dead.